The Cost of Trust: The invisible, obvious idea driving Web3 distribution
Do you want to really understand why web3 is an incredibly big deal and what will change from web2 to web3? A timeless human problem is solved better than ever before by this new technology, which has barely begun to be distributed. Let me show you the future few others see.
This post focuses on two ideas.
Transactions Require Trust.
And…
Creating Trust is Expensive.
Trusting someone enough to trade is a core human problem, and has been forever. This problem is a key idea for seeing how web3 (blockchains, cryptocurrencies, and NFTs) can impact our society over the next 10, 20, and 100 years.
Transactions require trust
Transactions are good. This is a core concept of economics. Voluntary transactions benefit both participants, who are better off after a trade. If you don’t believe this, play a game of Settlers of Catan without trading allowed, and let me know how that goes for you.
Transactions require trust. There needs to be trust in order to transact. If you really know someone very well, you may not deeply inspect what they are offering you. If you don’t know them at all (or if the trade is very expensive, like a house or car) you will carefully inspect what they’re offering you.
Companies build trust through brands — reminding you that you’ve had good experiences with their brand before, and you can trust them to deliver again.
Whether you trust the person as someone you already know or can “read”, trust the company offering the trade, trust the people who recommended the company, or trust the integrity of the item being offered… you need some certain volume of trust in order to make a trade.
Where trust is not present, transactions don’t happen. There is a classic economics paper called “The Market For Lemons” which studied how transactions worked in the used car market, under different conditions of trust. The less trust there is, the fewer trades happen, the smaller the market becomes. Smaller markets mean more expensive transactions, less information, less liquidity, less investment.
Transactions are good.
Transactions require trust.
Less trust = less transactions. More trust = more transactions.
So, how do we create trust?
Creating Trust is Expensive
“But Trust is free, dummy!” I hear you thinking.
Trust is not free. We invest huge amounts of time, effort, and money into creating trust. Entire industries are devoted to creating trust to facilitate transactions.
This so consistently surrounds us like the air we breathe and take for granted until we’re deprived of it. We forget how hard we have to work to create trust.
A few examples:
Banks - what banks offer is trust. They facilitate a fancy transaction between you, the saver of money, and your neighbor bob, the borrower of money. They have a vault so you trust keeping your money and valuables safe with them. They spread bankruptcy risk over many people. They do a lot of paperwork to get the government to insure their bank (FDIC), so you can trust your money is protected from your bank being robbed or going bankrupt.
Banks mostly offer the same services at the same prices. Rates are very competitive, laws are restrictive.
Contracts - A contract is a device for creating trust. It outlines exactly the rules in which the transaction can take place, and protects both parties from malicious actions.
Auction Houses - From Sotheby’s to StockX, there are companies devoted to verifying pieces of art, assets, or culture and facilitating a trusted sale between two parties.
VISA - Whenever you use a credit card, you’re paying for trust, and so is your merchant. VISA creates certainty of payment, fraud prevention, chargebacks, and a paper trail. It’s not just credit you pay 3% for — it’s trust.
A lot more examples:
Referees
Regulators
Auditors
Accountants
Title Companies
The DMV
Home Inspection
Mastercard, PayPal, Square
The United States Treasury Department go brrrrr
Escrow
Stock Brokerage
Uber/Lyft
Airbnb
Yelp/Thumbtack
Tollbooths
Punchclocks
Certificates (birth, death, marriage, diplomas, and plumbing… to name a few)
One more tiny, stupid story to show how deep this goes: This past weekend I watched Sour Grapes, a documentary about private wine collectors and their auctions. The central story is about a fraudster who created and sold fake wines — $35 million dollars worth of fake rare wines. In 2014, he became the first person in the US to be convicted of this particular crime.
What struck me as I watched with this post brewing in my subconscious was all of the new resources that had to be poured into creating trust in this market. Collectors were hiring wine inspectors and private investigators. Auction houses were buying new equipment to detect forgeries.
Now because some asshole violated the trust of the market, we have less transactions. We have to work harder and spend more to create trust even in this tiny, frivolous little market of high-end wine collection.
Wine Fraudster. Don’t buy wine from this guy (when he gets out of jail)
One more example, since Charlie Munger deserves a shout-out in every post.
An underrated, completely pervasive instrument of trust: Cash Registers
“People who create things like cash registers, which make immoral behavior hard, are some of the effective saints of our civilization. The cash register was a great moral instrument when it was created.
Patterson knew that, by the way. He had a little store and people were stealing him blind. He never made any money. Someone sold him a couple of cash registers and the story started making a profit immediately. Of course, he closed the store and went into the cash register business.”
-Charlie Munger
“Patterson” is John Patterson, founder of NCR in 1884, which was like the IBM of Cash Registers. It still has a $5 Billion Market Cap today.
Trust is expensive. And, as we saw with The Market for Lemons paper… where trust doesn’t exist, it still costs us! There is opportunity cost to missing trust, so we invest a lot of time, money, and effort to create trust.
Since Transactions require trust, we use banks, contracts, auctions, brands, etc. for most transactions today. But banks aren’t the only way to do these transactions. If there was a cheaper way to create the trust necessary for these transactions, we’d probably prefer that.
Transactions are good.
Transactions require trust.
Less trust = less transactions. More trust = more transactions.
Creating trust is expensive.
And finally… the connection to where we are today:
Blockchains make trust cheaper
Without jargon or technical details, let me say simply: Blockchains make trust cheaper.
You will hear crypto fans parroting the line “blockchain enables trustless transactions!” They mean you don’t have to trust the other person/company/entity you’re trading with because the blockchain creates the trust.
“Trustless” isn’t a good term. “Extremely cheap assumed trust for any on-chain trade” is more accurate, and an important distinction. Blockchains are not “Trustless” but “Trustfull.”
This technology is not yet well distributed. We only have a few million active users of wallets (a decent measure of web3 participation), and only a small fraction of our transactions are on blockchains yet.
In 10, 20, or 100 years, the vast majority of our trades will move from “offchain” to “onchain”. In the exact same way most of our communications have moved from “offline” to “online” in the past 20 years. And, for the same reasons: much lower cost, much more speed.
The high cost of creating offchain trust is one of the key forces that will drive this movement, though few people will understand this at first. They’re blind to it because it’s everywhere. Once you see how much we spend on trust, you see how much there is to be gained by a technology that makes the creation of trust cheaper by 10x or 100x.
How would that asshole Rudy have sold $35 million in fake wines if the past 10 years of transactions in the rare wine market had been recorded on a blockchain for all to see and verify? Or if 100 years ago each bottle created had a token created to certify authenticity? Certainly, each auction house transaction recorded “onchain” for a few cents is cheaper than hiring experts to inspect and confirm the historical accuracy of each bottle.
Transactions are good.
Transactions require trust.
Less trust = less transactions. More trust = more transactions.
Creating trust is expensive.
Blockchains make trust much much cheaper.
But, we’ve barely begun to actually use blockchains.
It’s incredibly early.
This technology is barely distributed. Sure Bitcoin is in the news and everyone has heard of it. Lots of people even own it. But that isn’t what Blockchain is about. The true revolution happens as we move all transactions onchain. To an actual software solution for managing digital scarcity, which we’ve never had before.
We haven’t even begun the true web3 revolution, where everything from your car to your concert tickets moves onchain. What % of global transactions happen onchain today?
Well, since ~0.01% of internet users even have wallets, and on-chain transactions are probably <1% of the transactions those people do… I think we’re comfortably at 0.00001% progress of moving our world onchain. SEVEN orders of magnitude to go. 10,000,000x. TEN MILLION X.
So be patient, think long-term. The internet revolution is entering the next phase, and you can help move the world onchain. It’s going to make all of our lives better, and 2040 will look very different.
Want to learn more? Read the rest of my low-jargon, high-practicality, long-term outlook on web3:
I’ll be investing heavily in web3 companies, tokens, and projects. If you’re interested in co-investing, email or DM me and let’s talk about how to work together.
Not financial advice, do your own research. (NFI, DYOR)